The starting point is to determine the fair value of the stock. If you were to sell this to a third party for cash up front, what would the price be? That is the sale price of the stock and a note payable from your son to you should be drawn up in the year of the sale. Gain or loss should be calculated accordingly, noting if you take back a note and have a gain you can use the installment method. If using the installment method, interest should also be calculated each year.

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That said, I realize you want to do 5% of sales. That is fine, but the difference between what you receive (or do not receive) and the payments you should receive based on the note payable is going to be a gift.

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Example:

Given:

1) The fair value of the stock is $100,000 so you sell the stock to your son for that amount as you do not intend to gift it initially.

2) Your basis in the stock is $50,000, meaning that for each $1 you receive $0.50 is gain.

3) You take a note from your son to pay for the stock at 5% interest.

4) Per your agreement, you have your son pay you 5% of sales with a maximum loan period of twenty years (ie... state in your loan that after 20 years any unpaid principal balance is immediately due and payable).

5) In year one you receive $5,000.

6) In year two you receive $10,000.

7) In years three through twenty you receive $85,000 in principal payments plus interest.

8) Your son does not pay anything other than the 5% of sales for twenty years.

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Then:

1) In year one the entire $5,000 payment is interest revenue given the 5% interest rate and after year one the principal balance of the note remains $100,000.

2) In year two you receive $10,000, half of which is principal bringing the note balance down to $95,000 and half of which is again interest revenue to you. At this point, you would recognize gain of $2,500 having received $5,000 principal payments using the installment method.

3) After twenty years the balance of the note is $10,000 (this is the $95,000 balance after year two less the $85,000 in principal payments received during years three through twenty). If your son is not going to pay you the final $10,000 that is due and payable, it is a gift from you to him.

Excellent information, very quick reply. The experts really take the time to address your questions, it is well worth the fee, for the peace of mind they can provide you with. OrvilleHesperia, California

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